Phase 4: Paying off debt

If you’re like many Americans, you’ll find that your money is already spent before it even clears your bank account on pay-day. And it’s spent on debt. Your house payment. Your car payment. Your credit card payment. Your student loans. If you’ve got minimum payments to make, the money you earn isn’t really even yours. It belongs to your creditors. If you don’t believe me, go ask a bankruptcy judge.

Debt is unfavorable for two reasons:

  1. You’re paying interest to someone else.
  2. Every dollar spent on a minimum payments is a dollar you’re not investing.

If you think that your “small” $80/month credit card payment isn’t much, take a look at it from a different perspective. Every dollar invested on a monthly basis now will be worth approximately 280 times itself in 15 years (6% annualized returns).  That $80/month credit card means you’re missing out on $22,400 (80 x 280) 15 years from now.  Your $350/month car payment? $98,000! This rule is so cool, we’re going to name it The 280 Rule.  Daily $2.50 coffee equals ~$50/month. The 280 Rule says that little luxury is robbing you of $14,000! That’s a nice car!

The point of The 280 Rule is that every dollar that goes to a minimum payment is a dollar that is wasted. Even if you don’t want to retire earlier than 60, you could buy some pretty cool stuff with that money in 15 years. If you had $14,000 in your bank account right now because you skipped out on Starbucks 15 years ago, would you be ok with that? I certainly would.  Don’t even get me started on cigarettes.

So how do we get out of this colossal debt calamity? Pay it off. Scrap, scrounge, scavenge, and sell until your only debt is your mortgage. I’m serious here. Your debt is a tumor and it needs to be cut out before it becomes cancerous. Anesthesia or not.

There are two common strategies that people use to pay off their debt:

  • choose the highest interest debt and pay it off first
  • choose the smallest debt and pay it off first.

Either method will work, but I favor paying off the smallest debt first.  The feeling of paying off a debt is a tremendous mental boost.  It’s mentally  easier to wage a war when you’re winning and on the offensive. Will you pay a little more in interest this way? Yes. Is it a big deal? Not really. The important thing here is that you’re eliminating debt and changing your habits.  In the world of personal finance, small and consistent changes can make a huge difference.  Remember The 280 Rule!

Right about now is when a lot of people become uncomfortable.  Maybe you’re anxious that your quality of life is going to decrease.  Let’s talk about it.  There are many causes of depression, but this study demonstrates a strong correlation between debt levels and negative mental health side effects.  Additionally, take moment to visualize how you would feel if you had no car payment, student loan payment, and/or credit card payment.  Imagine how good that will feel. It’s something worth bragging about.

Let’s talk about some exceptions to the pay off your smallest debt first idea.  Let’s say you’ve got two credit cards: Card A and Card B.  Card A has a $4,000 balance and a 9.9% APR.  Card B has a $9,000 balance and an 18% balance.  If you choose to pay off your smallest debt first, you’ll attack Card A.  Meanwhile, Card B has an interest rate (18%) that is almost double that of Card A (9.9%).  In this scenario, it may make more sense to attack the higher APR first.  Is it necessarily bad if you still go with the smallest debt?  No.  Again, you’re attacking debt and changing your habits in a positive way.  But by attacking cards with somewhat small balances by prioritizing the higher APR, you’ll optimize the amount of money you end up paying.

Whoa.  Wait a second.  A $4,000 or $9,000 balance is small, your saying?!  Yes.  Absolutely.  It may seem like an insurmountable amount right now, but your retirement nest egg will be 100 times that amount.  I’m not saying it won’t be a challenge for you, because it will be.  But if you’ve got $13,000 in credit card balances, you can absolutely pay it off.  People routinely pay off balances that are ten times that amount (like a house or student loans!) when they dedicate themselves to the goal.

Action Items

  1. Write a list of all your debts.
  2. Next to each debt, write down the outstanding balance and the interest rate (APR).
  3. Order your debts from smallest to largest outstanding balance.  Do this on a physical piece of paper. Write hit list on the top and put it on your fridge.
  4. Put every possible cent towards paying off the first debt on your list. Every. Cent. Minimum payments will not do here.
    • Sell things on Craigslist to free up cash
    • Checkout “gigs” on Craigslist. There are many one-day jobs out there.
    • Pickup evening/weekend part-time work.
    • Stop spending. No restaurants. No shopping. No expensive vacations.
    • Think it’s beneath you to sell your blood plasma? It’s not. And if you’re willing to do this a few times to pay off a debt, you’re a badass in my book.
  5. If you’re making more than minimum payments on any other debts, back things off and only pay the minimum. The idea here is to dedicate resources and focus on one debt at a time. Nobody wants to fight a war on multiple fronts.
  6. Once you pay off your first debt, take the money you were just spending on it and immediately shift it to the next debt.
  7. Celebrate success! Find someone to give you a real-life high-five. You’re making progress and you should feel pumped about it. Just don’t celebrate with a nice night out if you’ve got more debt to slash. Physically cross off that debt from your hit list.

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